Accounting for Intangibles: Does Method of Accounting Matter?
ABSTRACT
The purpose of this study is to determine if method of accounting for intangible-related
transactions matters. One hundred four subjects are asked to determine the effect on
future earnings of a company with internal research and development expenditures. In
one scenario, the company capitalizes the intangibles as is allowed under International
Financial Reporting Standards. In the other scenario the research and development
expenditures are expensed as required by US GAAP. Results indicate that users’
perceptions of value of intangibles are affected by how those intangibles are reported.
Large expenditures are deemed more valuable by users when capitalized versus small
expenditures. Based on the outcome of the experiment, it appears that users’ perceptions
of the benefit of intangible expenditures can be influenced by the accounting treatment,
even though the expenditures should have the same impact on future earnings.
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Accounting for Intangibles: Does Method of Accounting Matter?
INTRODUCTION
The goal of this study is to understand the market’s reaction to differences in
reporting intangible-related transactions. Intangible-related transactions are often
accounted for differently, depending on the set of accounting principles followed by the
company engaging in such activity. For example, companies adhering to US Generally
Accepted Accounting Principles (GAAP) account for research and development costs as
an expense; however, development costs are often accounted for as an asset by
companies prescribing to International Financial Reporting Standards (IFRS). The
primary question of interest in this study is whether the market is efficient in
understanding that these transactions are identical in nature even though they are
accounted for differently to adhere to particular reporting requirements. A secondary
question of interest in this study is whether any perceived differences in the intangible
expenditures based on accounting treatment are affected by the size of the expenditure.
In other words, does size of an intangible-related transaction affect investors’ perceptions
of its benefit on future earnings when the intangible is expensed versus capitalized?
One hundred four undergraduate and graduate business students from a major
university in the United States serve as subjects of a behavioral experiment conducted to
explore these research questions. Subjects were given one of four instruments, two of
which described a US automobile manufacturing company engaging in research and
development and the other two describing a UK automobile manufacturing company
engaging in the same activities. Within each of the two countries, the size of the
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development costs is varied from a small amount to a large amount. In accordance with
US GAAP, these expenditures are expensed by the US company, thus reducing current
year’s net income. The UK company capitalized these expenditures to align with IFRS,
thus current year’s net income is not affected. After reading about the intangible-related
transactions of the company and analyzing its financial statements, subjects were asked to
assess the expected benefits that these transactions would have on future earnings.
Factorial ANOVA is used to analyze the data. The results of the statistical
analysis indicate that method of accounting does affect investors’ perceptions of
intangibles’ future benefits on earnings. Size of the expenditure also interacts with
accounting treatment to effect users’ perceived benefit of the transaction. The overall
finding of this experiment is that perceived benefit of an intangible-related transaction
depends on the combination of accounting treatment and size of the expenditure. While
the perceived future benefit of a large intangible-related expenditure does not
significantly differ based on accounting treatment, expenditures of small amounts are
perceived differently by investors based on accounting treatment. Even though two small
expenditures are identical in nature, their perceived benefits vary significantly based on
accounting treatments of the expenditures. Small expensed intangibles are viewed more
favorably by investors relative to small capitalized intangibles. Therefore, two identical
transactions that are accounted for differently are not necessarily perceived by the market
as having identical impacts on future earnings. According to subjects’ perceptions,
whether a large or small expenditure for intangibles will be more beneficial on a
company’s future earnings may depend on accounting treatment of such expenditure. If
the expenditure is treated as an asset, a large expenditure is viewed more favorably than a
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small expenditure. However, if the expenditure is expensed, significant differences do
not exist between large and small expenditures. International consensus on how to
properly account for intangible-related transactions is integral. Without international
consensus on how intangibles should be accounted for, comparability of multinational
companies is hindered.
BACKGROUND AND HYPOTHESES DEVELOPMENT
Intangible assets are identifiable (separable) non-monetary sources of probable
future economic benefits to an entity that lack physical substance, have been acquired or
developed internally from identifiable costs, have finite life, have market value apart
from the entity, and are owned or controlled by the firm as a result of past transaction or
event. The ratio of intangible assets relative to tangible capital assets has nearly flipflopped from 1929 to 1990. In 1929, the ratio of intangible assets to tangible assets was
30:70; in 1990, the ratio was 63:37 (Canibano, et al., 2000). Segelod (1998) researched
the change of companies’ assets in Sweden for years 1964, 1977, 1990, and 1993. The
results show that companies are investing more and more in intangibles and that guidance
is needed by management to determine how to account for such investments, particularly
those internally developed intangibles expected to provide future value to the company,
which are expensed as opposed to capitalized in accordance with financial reporting
requirements.
The primary choices for accounting for an intangible per FASB’s SFAS 141,
“Business Combinations,” and SFAS 142, “Goodwill and Other Intangible Assets,” are as
follows: 1) an asset without amortization, 2) an asset with annual impairment testing, 3)
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an asset with systematic amortization, and 4) an expense. Basically, US standards
mandate that externally acquired intangibles be capitalized, while internally generated
intangibles are to be expensed. Externally acquired intangibles with finite lives are to be
amortized over the shorter of their economic or legal life. Those externally acquired
intangible assets with an indefinite life are not to be amortized but rather checked
annually for impairment. An intangible is said to have become impaired when its
carrying value (book value) exceeds its fair market value. To adhere to the conservatism
principle of accounting, when such impairment occurs the intangible is written down to
its fair market value with a corresponding charge to the income statement.
While it is the norm in the US to expense internally generated intangibles, the
AICPA has been responsive in the past to recognize that some internally generated
intangibles should be presented on the face of the balance sheet. The AICPA’s Statement
of Position (SOP) 93-7 mandates that direct-response advertising that can be expected to
result in benefits in future periods be capitalized as an intangible asset, given the benefits
are measurable and a company makes certain disclosures. Such direct-response
advertising is to be amortized, on a cost-pool-by-cost-pool basis, over the estimated time
of benefit (Flesher, et. al., 2002). Therefore it is not unreasonable to think that the FASB
would allow other internally generated intangibles with potential future value to be
capitalized.
The International Accounting Standards Board (IASB) hopes to create a
framework that will establish international agreement on how to account for intangibles.
Because of the nature of intangible assets, such a task is quite daunting. By definition a
company’s assets are its resources with potential future value. Since intangible assets
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lack physical existence, measuring their potential value is not easy and is quite
subjective. The major reason that internally generated intangibles have not been treated
the same as externally acquired intangibles is because internally generated intangibles are
extremely difficult to value. Arriving at relevant and reliable figures can be problematic
(Radebaugh et. al., 2006).
International Accounting Standards related to accounting for intangible
expenditures are principles-based, relative to rules-based US GAAP. The IASB attempts
to create standards that will account for these expenditures in a manner that most
appropriately reflects the underlying nature of such transactions. Rather than mandating
that these expenditures be accounted for in a certain manner depending on how the
transaction arose (internally or externally) the IASB attempts to create standards in such a
way that if the expenditure has future value, it is accounted for as an asset; if it does not,
it should be expensed. IAS 38 mandates that identifiable intangibles be capitalized if
they have probable future benefit to the company and the costs of the intangible can be
measured reliably. If such recognition criteria cannot be met, IAS 38 requires that the
expenditure be expensed when it is incurred. This treatment applies to both externally
acquired and internally generated intangibles.
Companies adhering to IFRS must classify intangible assets based on their lives—
assets with indefinite or finite lives. Those with finite lives are amortized over their
useful lives. Those with indefinite lives are checked annually to determine if their lives
are still indefinite and to determine if they have become impaired. Assets that become
impaired are written down to net realizable value. However, if such impairment reverses,
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those intangibles may be written back up, unlike intangibles tested annually for
impairment under US GAAP (IAS 36).
IAS 38 offers specific guidance for how to treat certain intangible-related
expenditures. Like US GAAP, IASB mandates all research costs be expensed. However,
development costs may be capitalized if they meet the recognition requirements
described above. Internally generated brand names, mastheads, titles, and list are specific
items that should not be recognized as assets per IAS 38. Purchased computer software is
capitalized; internally developed software is capitalized if it can be determined to have
benefit to future periods. Internally generated goodwill, start-up costs, and advertising
costs must be expensed.
The purpose of this paper is to test whether developing international consensus on
how to account for intangible-related transactions is necessary. Arguably, the method of
accounting for intangibles may not matter. If two countries account for the same
intangible-related transaction differently and the market is efficient, the market’s reaction
to such transaction will be the same. The method of accounting for the intangible will
not matter if the market is efficient. As long as a company discloses information about
its intangibles and how they were accounted for, share prices will not differ as accounting
treatment of intangible-related transactions differs in efficient markets (Radebaugh et. al.,
2006). This study is motivated and warranted due to the current increased talk of a need
for international consensus on accounting for intangibles (Radebaugh et. al., 2006).
Further, it is important to investigate whether users understand and account for
differences in US GAAP and IFRS given that the Securities and Exchange Commission
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is contemplating allowing U.S. companies and foreign registrants to file using IFRS
(SEC, 2007).
Existing literature finds that market does value reported intangibles. Disclosed
intangibles, while consistently undervalued compared to tangible assets, are valued
positively (Choi et al., 2000). Lev (1999) conducted an archival investigation of
intangibles including research and development, goodwill, and brands. He found the
market values intangibles regardless whether they are treated as an asset on the balance
sheet or an expense on the income statement. Regardless of the treatment of the
intangible-related transaction, the market is efficient to recognize the underlying nature of
the transaction and positively values the intangible as long as the information is disclosed
(as an asset or as an expense). Knowing that GAAP does not allow internally created
intangibles to be capitalized, the market recognizes that potential future value flows from
a transaction that is expensed simply in order to align with GAAP.
Hirschey (1982), Hirschey and Weygandt (1985), Cockburn and Griliches (1988),
and Hall (1993) all researched the market’s reaction to companies’ disclosed research and
development expenditures. Each find that the market positively values such
expenditures. Even though the research and development expenditures are expensed on
the financial statements to align with GAAP, the market recognizes such expenditures as
assets with potential future value (Ballester et. al., 2003). Sougiannis (1994) created an
earnings model showing that research and development expenditures increase future
income and a stock valuation model to show the market indeed does value such
expenditures. Studies by Woolridge (1988) and Chan et. al. (1990) find that the market
also reacts to companies that announce their research and development expenditures.
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Bublitz and Ettredge (1989) find positive abnormal returns when the market becomes
aware of unexpected research and development expenditures of a company. The
expenditures, regardless how they are treated for financial reporting purposes, are viewed
as investments and are expected to benefit the companies engaging in research and
development investments, per the market’s reaction.
Research also shows that users of financial information understand GAAP
reporting requirements and hence recognize that many intangibles never reach the
financial statements (Barth et. al., 2001). Since stakeholders positively value information
about investments in intangibles, many companies voluntarily disclose information
beyond the requirements of GAAP. Entwistle (1999) finds that the amount of disclosure
a company makes about its intangible expenditures depends on what management wants
the market to know, implying that management realizes that the market and analysts
value disclosures about its intangibles. Gelb (2000) finds analysts give higher ratings for
supplementary disclose to companies with higher investments in research and
development and advertising than to those which have fewer expenditures on intangibles.
The supplemental disclosure is provided by companies because the financial statements
alone are insufficient in communicating information about intangible-related transactions.
Several countries’ GAAP facilitate more disclosure of intangibles than US
GAAP. Prior to adopting IFRS, both Australia and the United Kingdom allowed
internally generated intangibles to be capitalized. Goodwin (2003) and Abrahams and
Sidhu (1998) found that the Australian market values the disclosure of internally
generated intangibles. Those firms that capitalized internally developed intangibles are
viewed more favorably by the market than those firms that expensed such expenditures
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(Smith, et al., 2001). Alford, et al. (1993) find that Australian and the United Kingdom’s
financial statements are just as useful and informative, if not more useful and
informative, than US financial statements. They note that Australian and UK financial
statements are often more informative due to the fact that they provide more disclosure,
specifically about intangibles. Investors use information reported on these countries’
financial statements about internally generated intangibles when evaluating companies’
earnings potential (Godfrey and Koh, 2001). As additional updated information about
internally generated assets is disclosed, the market reacts favorably to the release of new
information. Barth and Clinch (1998) found that Australian companies that updated the
value of their intangibles were treated favorably by the market.
Studies of British companies have found similar results to those of Australian
companies. As Australian GAAP allowed the capitalization of internally generated
intangibles, the United Kingdom did as well (prior to the adoption of IFRS). Mather and
Peasnell (1991) find that British companies that disclosed internally generated brand
names by capitalizing them reaped positive benefits in the market. Barth, et. al. (1998)
and Kallapur and Kwan (2004) find that the disclosure of internally developed brand
names by British companies provides valuable information to the market. The
announcement of brand names yields positive abnormal returns. The problem associated
with communicating information about internally generated intangibles is the difficulty of
valuing them. However, they are nonetheless valuable and should be disclosed in the
financial statements (Amir and Lev, 1996). Even though the value of the brands and
other internally generated intangibles is somewhat subjective, the market appreciates the
disclosure of internally generated brands and recognizes that their values are subjective
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and non-exact. Arguably, companies that are not disclosing their brand names (such as
US companies and companies following IFRS) are not communicating valuable
information to stakeholders.
Wyatt (2005) finds that US financial statements may have substantially less value
than they could because internally generated intangibles are not reported on financial
statements, as required by GAAP reporting requirements. Valuable information is
withheld from stakeholders of US financial statements. Limiting managements' choices
to record intangible assets tends to reduce, rather than improve, the quality of the balance
sheet and investors' information set. Luft and Shields (2001) find that the accounting
method of intangible-related transactions does affect users of financial statements. If
stakeholders are told the intangible-related transaction was expensed, they underestimate
the value of the expenditure on future periods’ earnings. However, if the exact same
transaction is capitalized, future profits are predicted more accurately. Their study finds
through experimentation that when investors predict future profits using information on
intangible expenditures, expensing (versus capitalizing) the expenditures significantly
reduces the accuracy, consistency, consensus, and self-insight of profit predictions.
Therefore, based on these two behavioral experiments, not only do stakeholders need
disclosure of intangibles in the financial statements, but the intangible needs to be
accounted for as an asset and thus capitalized. It is from this literature that hypothesis
one of this study is derived.
The results of these various aforementioned studies on intangibles yield
conflicting findings. Results for Lev (1999) indicate that the (US) market is efficient in
understanding intangible-related transactions regardless if they are expensed or
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capitalized. Luft and Shield’s (2001) findings indicate that stakeholders’ assessments of
companies’ financial statements are impacted by the method of accounting of intangiblerelated transactions. Investors’ assessments of the transactions depend on whether they
are capitalized or expensed. Results of other studies mentioned above indicate that other
countries’ GAAP, such as the UK’s and Australia’s, provide for more informative
financial reporting relative to US GAAP (Alford, et. al., 1993; Mather and Peasnell,
1991). Prior to their adoption of IFRS, companies in these countries were allowed to
disclose internally generated intangibles as assets. These mixed results indicate that
future research is needed to understand how accounting treatment affects users’
assessments of the value of intangible expenditures. It is obvious why the IASB has had
such difficulty in adopting acceptable international accounting standards on accounting
for intangibles.
One major area that cannot seem to get reconciled between the US and IFRS is
accounting for research and development costs. Per US GAAP, all research and
development expenditures flow through the income statement as an expense when
incurred. FASB argues that such requirement is a conservative, practical method of
accounting for research and development which insures consistency in practice and
comparability among accompanies (Millan, 2005). FASB also postulates that the
accounting method of such R&D expenditures makes little long-run difference from an
income statement approach. Arguably, the amount of R&D that would be expensed on
the income statement would be approximately the same each accounting period
regardless whether standards mandate immediate expensing or capitalization followed by
amortization. Most companies engaging in R&D continue such activities in subsequent
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years (Millan, 2005). Conversely, while all expenditures related to research must be
immediately expensed, IFRS allows the expenditures for development costs to be
capitalized on the balance sheet as intangible assets if specific criteria are met. The cost
is then amortized on a straight-line basis over the expected useful lives of the products for
which they were incurred. The main difference between IFRS and US GAAP is that
IFRS recognizes that sometimes a business is able to identify development expenditures
that fulfill the requirements to be recognized as an intangible asset. From the perspective
of IAS 38, such intangible assets should not be accounted for any differently than those
acquired externally. If, however, the expenditure does not meet the criteria for asset
recognition, such expenditure should be recognized as an expense and may never be
recognized as an asset. The treatment of in-process research and development acquired
through business combination is also accounted for differently under US GAAP and
IFRS. US GAAP mandates that the portion of the purchase price attributable to inprocess R&D be written off as expense immediately, while IFRS 3 mandates that such
costs be recognized as a separate asset from goodwill or any other asset. While the IASB
and FASB both pledge to make IFRS and GAAP as compatible as possible, such
convergence on accounting for R&D expenditures does not seem promising in the near
future. Since neither organization is willing to compromise on this issue, attempts for
convergence on this issue have been temporarily suspended (Millan, 2005).
According to the efficient market hypothesis, all publicly available information is
quickly incorporated into stock share prices. The prices of traded assets (i.e. shares of
stock) reflect all known information about the company and what investors project for the
company’s future (Fama, 1970 & 1991; Lev, 1999). If the efficient capital market
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hypothesis is true, the method of accounting for intangibles is irrelevant. Whether an
intangible is expensed or capitalized with or without amortization or capitalized and
checked annually for impairment will not affect the investors’ understanding of the true
economic underlying of the intangible-related transactions as long as disclosure about the
intangibles and how they were accounted for are fully made. If the market is efficient, it
will realize and understand the nature of the intangible-related transactions regardless of
the accounting treatment of such transactions. However, Luft and Shields (2001) find
that the accuracy of predicting future profits of a company is influenced by how
transactions are accounted for. Based on Luft and Shields (2001), hypothesis one of the
paper is that the market is inefficient in recognizing that two transactions are identical in
nature if they are accounted for differently. The first hypothesis of interest in this study
is as follows:
H1: Ceteris paribus, the market’s reaction to two identical intangible-related
transactions will differ as accounting treatment of such transaction differs.
If the market is inefficient with respect to intangible assets, the IASB should
resume efforts to find consensus of accounting method for intangible-related expenditures
If, however, the results of this study indicate that the market is efficient, the IASB should
focus its efforts on mandatory disclosure of intangible-related transactions as opposed to
method of accounting for intangibles.
The second issue tested in this experiment is whether the size of intangible
expenditure affects investors’ perception of its benefit based on whether the expenditure
is expensed versus capitalized. Arguably, a small expenditure may be assessed by
investors the same way no expenditure will be perceived. To effectively manipulate the
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amount of the expenditure, size in this study is manipulated based on the assumption of
materiality from other studies.
Materiality is not a simple calculation. Rather it is a determination of what will or
will not affect the knowledgeable investors’ decisions given a specific set of
circumstances related to the fair presentation of a company’s financial statements and
disclosures concerning existing or future debt and equity instruments. According to SFAS
34, interest of certain assets must be capitalized only if the effects of capitalization are
deemed material. Jordan and Clark (2004) find that when defining materiality for
capitalizing interest, 4 to 5 percent or less of operating income is considered immaterial.
Thus capitalizing or expensing expenditures of immaterial amounts of interest should not
affect stakeholders’ analyses of financial statements. However, interest amounting to
more than 5 percent of income should be capitalized in order to align with SFAS 34.
The “5% rule” remains the fundamental basis for working materiality estimates.
Because a qualitative analysis of determining materiality is very complex, almost
everyone—including CPAs—uses quantitative estimates to identify potential materiality
issues (Vorhies, 2005). Therefore to manipulate size in this study, a large expenditure is
defined as an amount greater than 5% of net income; a small expenditure is defined as an
amount less than 5% of net income. Large expenditures are expected to have a greater
(positive or negative) influence on investors than small expenditures. The second
hypothesis of interest in this study is as follows:
H2: Ceteris paribus, the market’s reaction to two identical intangible-related
transactions will differ as size of the expenditure differs, given the amount of such
transaction is fully disclosed.
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The third hypothesis of this study is derived from the interaction of the two
aforementioned hypotheses. Arguably, as postulated in hypothesis two, as level (amount)
of an intangible expenditure differs, investors’ perception of the benefits of such
expenditure may differ. The third question of interest is whether a large or small
intangible-related expenditure is perceived more favorably by investors when it is
accounted for in particular manner—capitalized or expensed. In other words, will
investors’ perceptions of future benefits of intangible-related expenditures depend on
both method of accounting and size of the expenditure in combination? The third
hypothesis of interest in this study is as follows:
H3: Ceteris paribus, the market’s reaction to two identical intangible-related
transactions accounted for differently will differ as size of the expenditure differs,
given the accounting treatment and size of such transaction is fully disclosed.
METHODOLOGY
Subjects
In order to test the hypotheses of the study, a behavioral experiment is conducted.
One hundred four upper-level undergraduate and masters-level accounting students of a
state university in the United States serve as the subjects of this experiment conducted in
June 2007. Studies show that MBA students who have completed a financial statement
analysis course are able to acquire and use financial information in a similar manner to
nonprofessional investors when making investment-related judgments and decisions
(Elliott, et. al., 2007). All subjects in this study are upper-level or master’s-level
accounting majors who should have an extensive understanding of financial statements.
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Therefore the subjects who participated in this study are appropriate proxies for
nonprofessional investors.
Twenty-eight subjects participated in the capitalize/large expenditure
manipulation group; twenty-four subjects comprise the capitalize/small expenditure
group; twenty-four subjects make up the expense/large expenditure group; twenty-four
subjects participated in the expense/small expenditure manipulation. Ideally, twenty-six
subjects would comprise each group, giving each manipulation group the same number of
subjects. However, since data was collected at various times, unequal group sizes
occurred. Creating unequal group sizes is not intentional; however, results are not
skewed by the slight difference in group sizes.
Instrument
Subjects were randomly assigned one of four versions of the instruments located
in the appendix of this paper. They were asked to determine the benefit of an intangiblerelated expenditure after reading a narrative describing the intangible-related activities of
a company. Pro-forma financial statements accompany the instrument to assist subjects
in their analysis. Since convergence of US GAAP and IFRS related to R&D
expenditures (specifically development costs) has been difficult and remains unresolved,
the intangible development costs was chosen as the intangible of the experiment. The
purpose of the instrument and experiment is to determine if accounting treatment and
amount of these development costs affect subjects’ perceived future benefits of the
expenditure.
The US and UK companies described in this experiment are automobile
manufactures. Both companies are described identically as heavily engaging in research
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and development related to improving the development of their hybrid automobiles.
Most individuals are familiar with automobile manufacturing and sales and can relate to
research and development expenditures to improve the automobiles. The idea to use an
automobile manufacturing company stems from an actual automobile manufacturer’s
2006 annual report. DaimlerChrysler, a German-based international company, informs
its stakeholders of the divergence between US GAAP and IFRS on accounting for
development costs, as described in the related literature section of this paper. To adhere
to IFRS, DaimlerChrysler plans to capitalize development costs that meet the criteria set
forth in IAS 38 as intangible assets. These costs will become a part of the production
costs of the vehicles in which the component for which such costs were incurred is used.
Once these vehicles are sold, the amortization of development costs is expensed and not
in “research and non-capitalized development costs.” This experiment decribes
automobile manufacturing companies engaging in research and incurring development
costs. The method of accounting for development cost and the dollar amount of the
expenditure are the manipulations of this behavioral experiment.
To manipulate accounting method, the instrument used to conduct this experiment
describes a US company and UK company. The UK currently reports financial statement
in accordance with IFRS. (The UK has been capitalizing development costs for years;
such practice is currently required by IFRS when particular criteria are met.) In
accordance with IFRS, the UK company described in the instrument capitalizes these
expenditures. Accordingly, these expenditures are placed on the balance sheet as
intangible asset. These expenditures in no way affect the current year’s net income of the
company engaging in the internal development activities. Adhering to US GAAP, the US
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company expenses these expenditures, reducing current year’s net income. Accordingly,
these expenditures did not ever show up on the balance sheet as an asset. However,
management of the US company chooses to disclose within the notes of the financial
statements that these expenses relate to the internal expenditures related to development
costs arriving from research.
Two versions of the experiment were created for each of the countries represented
in order to test hypothesis 2 of the study. The level of research and development
activities of each of the two companies described is varied. In accordance with the 5%
rule of materiality described previously, one company’s intangible-related expenditures is
less than 5% of net income, while the other company’s transactions total more than 5% of
current year’s net income. The US company’s net income is reduced by either 4.6%, a
small amount, or by 81.5%, a large amount. Accordingly, the UK company capitalizes
the intangible-related transaction by one of the two same dollar amounts. After reading
about the company and its development activities and after analyzing the company’s
financial statements, subjects are asked two questions relating to whether such
expenditures will be beneficial to the company in future years.
Pilot test
Prior to conducting the actual experiment, a pilot test was administered to ensure
that subjects would understand the experiment. The twenty-four participants of the pilot
study were drawn from an undergraduate accounting course at a state university in June
2007. Upon completion of pilot test, the subjects participated in a discussion forum.
They indicated that the experiment was comprehensible and quite self explanatory. The
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results of the pilot study were almost identical to those of the actual experiment, which
are described in the following section of this paper.
Statistical Methods
To test the hypotheses of interest of this study, the experiment is designed as a
2X2 between subjects experiment, with two levels of accounting treatment of an
intangible-related transaction crossed with two levels of size of the intangible-related
transaction. By manipulating only accounting treatment and size of the intangible-related
expenditure, these two variables can be analyzed to determine if they affect subjects’
perception on the intangible’s future benefit.
Factorial Analysis of Variance (ANOVA) is applied to the data collected in the
experiment. The purpose of this statistical analysis is to determine if there is a
relationship between independent variables and a dependent variable. Factorial ANOVA
applied to the data collected from the 104 subjects’ responses to the experiment described
above determines whether accounting treatment, size, and/or the interaction of accounting
treatment and size are significant indicators of subjects’ responses and thus account for
the variance of investors’ perceptions of intangible-related expenditures’ benefit on future
earnings. The independent variable accounting treatment is coded one (1) for IFRS
treatment and two (2) for GAAP treatment. The independent variable size is coded one
(1) for a large expenditure; small expenditures are coded two (2). The dependent variable
in this study is the subjects’ perceived benefit of a company’s intangible-related
expenditures. Two questions are asked in the experiment to capture these perceptions.
Responses to questions one and two of the experiment are treated as the dependent
variables. Question one asks subjects to indicate on a scale of one to ten how beneficial
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the intangible-related expenditure (asset or expense) will be on future earnings, with one
representing not beneficial and ten representing very beneficial. The second question
asks subjects how likely they would be to invest in the company engaging in the
intangible-related expenditures described in the instrument. The scale for this question
also ranges from one to ten, with one representing not likely to invest and ten
representing very likely to invest. The purpose of both of these questions is to capture
subjects’ perceived benefit of the intangible-related expenditures, which are either large
or small in size and accounted for as either an asset or an expense.
RESULTS
Demographics
Two demographic characteristics of the subjects—gender and level of
education—were collected and analyzed with the data from the experiment. Sixty-one
males and forty-three females participated in the study. Sixty-two of these subjects were
upper-level undergraduate students; forty-two of these subjects were enrolled in a master
of taxation or master of accountancy program. Each of these demographics is entered
into the ANOVA to determine if they are associated with the dependent variable, thus
accounting for the variance in subjects’ responses. When entered into the model alone or
in conjunction with the other independent variables—method and size—neither gender
nor level of education of the subjects is significantly related to the dependent variable.
Therefore, neither demographic variable is included in the ANOVAs.
[Insert Table 1 Here]
21
Overall ANOVA results
Table 2 provides the average scores to the dependent variables which represents
investors’ perceived future benefit of the intangible-related expenditures. These averages
are the best predicted values of the dependent variable, given a particular accounting
treatment and size of the intangible-related expenditure. Questions one and two of the
experiment are on a ten point scale, thus mean scores of one through five represent
negative perceptions and six through ten represent positive perceptions. The average
responses to each of the questions (except for one) is greater than 5.5, indicating that the
expenditures are perceived to have positive benefits on future earnings. This finding
aligns with the research addressed earlier, indicating that both capitalized and expensed
research and development costs are viewed favorably by the market (Ballester, et. al.,
2003; Cockburn and Griliches, 1998; Hall, 1993; Hirschey, 1982; Hirschey and
Weygandt, 1985).
[Insert Table 2 Here]
However, the degree of perceived benefit varies significantly as method of
accounting and size of the expenditure vary. As shown in Table 3, each of the overall
ANOVA models is statistically significant at the p<0.01 level; the F statistic for each
overall model ranges from 6.177 to 7.618, depending on which variable is treated as the
dependent variable. The variance accounted for (adjusted R2) by these regression
equations ranges from 13.1% to 16.2%.
[Insert Table 3 Here]
22
Accounting Method
Hypothesis one of the study suggests that investors’ responses will differ as
accounting treatment of the intangible-related transactions differs. The independent
variable method is marginally significant in when Q1 is treated as the dependent variable.
The F-statistic for the independent variable accounting method is 3.197 and 1.079 when
question one and question two respectively are treated as the dependent variable. The
variable is significant at the p-value<0.10 level when Q1 is considered the dependent
variable. Thus, hypothesis one is not rejected. Method of accounting significantly
accounts for the variance in investors’ responses. The marginally statistically significant
independent variable method indicates that investors will not perceive the benefit of a
company engaging in identical intangible-related transactions the same if they are
accounted for differently.
Size
Hypothesis two of the study suggests investors’ responses will differ as size of the
intangible-related transactions differs. The independent variable size is statistically
significant in each of the ANOVA models, indicating that hypothesis two should not be
rejected. The F-statistic for this variable is 5.925 and 7.858 when question one and
question two respectively are treated as the dependent variable. Each of these F-statistics
has a p-value < 0.05. Thus, size (or amount) of a company’s intangible-related
transactions significantly accounts the variance in investors’ responses. As size of the
expenditure varies, investors’ expected benefit from the expenditure varies. The
statistically significant independent variable size indicates that investors do not perceive
23
that the future effects on income from engaging in intangible-related transactions of small
size to be the same effects as those transactions of a large size.
Interaction Variable (MethodXSize)
Hypothesis three postulates that the combination of accounting treatment and size
of an intangible-related expenditure affects investors’ perception of its future benefit.
The interaction of these two independent variables method and size is found significant in
each ANOVA model. The F-statistic for the interaction variable is 10.027 and 14.314
when question one and question two respectively are treated as the dependent variable.
Each of these F-statistics has a p-value < 0.01. Investors’ perception of the expenditure’s
benefit depends upon the condition of the other independent variables in the regression
equation. Investors’ expected benefit of the expenditure does not depend solely on the
method of accounting for the expenditure or the size of the expenditure but rather on the
combination of the two. Thus, hypothesis three is not rejected.
Alone, the marginally statistically significant independent variable method
indicates that investors will not perceive the benefit of a company engaging in identical
intangible-related transactions the same if they are accounted for differently. Also,
considered alone, the statistically significant independent variable size indicates that
investors do not perceive that the future effects on income from engaging in intangiblerelated transactions of small size to be the same effects as those transactions of large size.
However, neither of these statistically significant variables alone truly reveals
how investors perceive a company’s intangible-related expenditures. It is the interaction
variable that offers the most meaningful information to the international accounting
world. The statistically significant interaction variable found in each of the predicted
24
regression equations indicates that an investor’s perception of the benefit of an
expenditure for intangibles does not depend merely on how it is accounted for or the size
of it but rather on the combination of the two.
The findings of this study indicate that how investors perceive the future benefits
of an intangible-related expenditure depends not only on how the expenditure is
accounted for but also on the size of the expenditure. While the substance of these
transactions is identical, their perceived benefits on future earnings may be quite
different. Pairwise comparisons discussed below reveal where differences among groups
exist.
The ultimate goal of both of ANOVA is to determine if a relationship between
two or more variables exists. The ANOVA results indicate that the variable accounting
treatment is not statistically significant at the p < 0.05 level when questions one or two is
treated as the dependent variable. This variable accounting treatment is however
significant at the p < 0.10 level when question one is treated as the dependent variable.
The independent variable size is significant at the p < 0.05 level when question one is
treated as the dependent variable and at the p < 0.01 level when question two is treated as
the dependent variable. However, these findings are somewhat meaningless since the
interaction of accounting treatment and size is found significant. When an interaction
term is found significant in ANOVA, main effects must be interpreted with much
caution. The interaction term accounting treatment X size is significant at the p < 0.01
level regardless whether question one or two is treated as the dependent variable. This
finding indicates that an investor’s perception of the benefit of an expenditure for
intangibles does not depend merely on how the expenditure is accounted for or the size of
25
the expenditure but rather on the combination of the accounting treatment and size of the
expenditure.
Based on the results of this study, the IASB and the US FASB need to resume
convergence efforts to decide how to properly account to intangibles, specifically
development costs. When US companies following GAAP expense development costs
and companies reporting under IFRS are capitalizing these expenditures, investors are
valuing identical transactions differently. If these expenditures truly do have potential
future benefits to the companies engaging in these transactions, investors analyzing US
financial statements are undervaluing the expenditures’ benefits on future earnings. Also,
if these expenditures are providing little or no benefit beyond the current accounting
period, investors analyzing companies reporting under IFRS are overvaluing the future
benefits of these material expenditures. The findings of this study indicate that investors
do not perceive the future benefits of identical (large or small) expenditures that are
accounted for differently in the same manner. Therefore, to make international
companies’ financial statements comparable, consensus is needed.
Pairwise Comparisons
In order to further understand the meaning of the statistically significant
interaction term of the ANOVAs, pairwise comparisons of manipulated groups is
conducted, revealing exactly where differences among groups exist. Simple t-tests reveal
differences among the following four groups: IFRS treatment of a large expenditure,
IFRS treatment of a small expenditure, GAAP treatment of a large expenditure, and
GAAP treatment of a small expenditure.
26
A statistical difference exists between groups that treat the expenditure as an asset
(IFRS treatment). A large expenditure accounted for as an asset is perceived significantly
more beneficial than a small expenditure that is accounted for as an asset. This finding is
logical. A large resource has more potential future value than a small resource.
However, an expenditure that is accounted for as an expense (GAAP treatment) is not
perceived differently based on size. The perceived benefit of a large versus small
expense does not statistically differ. In other words, a large amount expensed for
development is perceived no more beneficial by investors than a small development cost
that is expensed. However, if this expenditure has been capitalized, the large expenditure
would have been perceived more beneficial than the small expenditure. While these
expenditures are identical in nature, their perceived benefits differ as size and accounting
treatment of the expenditures differs.
Investors do not perceive the future benefits of a large expense differently than
the future benefits of a large asset. Both are perceived to have positive benefits on future
earnings. Based on this finding, if a company has large development cost expenditures,
investors will perceive the future benefit of these expenditures in the same manner,
regardless of accounting treatment. However, small expenditures are viewed differently
by investors based on accounting treatment. A small expense is perceived to be more
beneficial relative to a small asset. Perhaps, investors perceive a small asset as
insignificant when comparing it to the other assets and total assets of a company. This
combination of IFRS treatment and small size is the only group perceived by investors as
having a somewhat negative effect on the company; it is this group that has a mean score
27
of less than 5.5. Although the small expenditures are identical in nature, because they are
accounted for differently, investors perceive their future benefits differently.
These pairwise comparisons reveal that investors often perceive identical
transactions differently depending on how they are accounted for. It is the combination
of accounting treatment and size of the expenditure that accounts for how investors
perceive the future benefit of expenditures. If multinational companies’ financial
statements are going to be comparable, convergence is needed so that all companies will
be accounting for these expenditures in a manner that reflects the true underlying nature
of these transactions. Once the nature of these types of transactions is fully understood,
the IASB and FASB need to resume efforts to create international accounting standards
revealing the proper accounting treatment of such expenditures, specifically those
expenditures related to development costs. International convergence and consensus is
needed on how to properly account for development costs.
[Insert Table 4 Here]
CONCLUSION
The purpose of this study is to determine if method of accounting for intangiblerelated transactions matters. Different countries have conflicting acceptable ways of
accounting for intangible expenditures. With the international marketplace becoming
more united, the IASB strives to create standards that will establish international
accounting consensus. If company’s financials are going to be compared internationally,
arguably they need to be in the same financial language. If different countries are
accounting for transactions differently, comparability is hindered. Conversely, according
28
to the efficient market hypothesis, if two transactions are identical but they are accounted
for differently, investors will be efficient in understanding the substance of the
transaction as long as full disclosure of the transaction is made. Therefore, the first
question posed in this study is whether method of accounting of intangible-related
transactions influences investors’ perceived benefit of the expenditure. A second
question of interest is whether a large expenditure is perceived by investors to have the
same benefits as a small expenditure.
To investigate these two questions, a behavioral experiment is conducted. One
hundred four upper-level undergraduate accounting majors and masters-level accounting
students serve as proxies for nonprofessional investors. They are asked to determine the
effect on future earnings of a company engaging in intangible-related transactions.
Method of accounting and size of the intangible-related transaction are manipulated to
determine if these two variables are associated with subjects’ responses. Two companies
reporting under GAAP requirements expense a large or small intangible-related
expenditure. Two companies engaging in identical transactions reporting under IFRS
capitalize an identical large or small expenditure.
The results of factorial ANOVA indicate that investors’ perceptions of value of
intangible-related expenditures are affected by the method of accounting, even when full
disclosure of the nature of the transaction is made. Their perceptions of the benefits of an
expenditure are influenced by the accounting treatment of the expenditure. When an
expenditure reduces net income, a large expenditure is perceived no differently than a
small expenditure. However, when an expenditure is capitalized, investors perceive a
large expenditure to have a more beneficial effect on future earnings relative to a small
29
expenditure. When companies are engaging in large intangible-related expenditure,
accounting method does not influence investors’ perceptions of future benefit of the
expenditures. However, if the company has small intangible-related expenditures,
accounting treatment significantly influences investors’ perception of their benefits.
Even if the substance of intangible-related expenditures is identical, investors are
influenced by the accounting method of the expenditure when analyzing its expected
benefit on future earnings. It is the combination of both size and accounting treatment of
the expenditure that determines investors’ perceived benefit on companies’ intangiblerelated expenditures. Therefore the IASB needs to resume efforts on developing
international consensus on how to properly account for intangible-related expenditures,
specifically development costs.
A limitation of this paper relates to the fact that different markets have different
levels of efficiency. When developing international consensus of standards, the IASB
must recognize that not all markets will have the same level of efficiency in incorporating
all publicly available information into stock prices. Although different markets (UK and
US) were used in the experiment, all the subjects are US citizens and part of the US
marketplace. Future research could employ subjects from different markets to investigate
whether results differ.
Another limitation also relates to the subject pool. A recent study suggests that
graduate level business students who have completed a financial statement analysis
course serve as excellent proxies for non-professional investors (Elliott, et. al., 2007).
These subjects are most appropriate when the level of integrative complexity is relatively
low; however they are quite adequate even for tasks relatively high in integrative
30
complexity. The paper cautions that M.B.A. students that have not completed a first-year
financial accounting course were found not to perform similarly to non-professional
investors when asked to make an investment decision. While they seem to acquire
information similarly to non-professional investors, they do not integrate the information
into the investment decision-making process in a similar fashion. While not all of our
subjects were at a master’s level of education, all of the subjects have completed basic
financial accounting courses; therefore, this concern is addressed and mitigated.
Arguably, upper-level accounting students have as much, if not more, understanding of
financial statement information than MBA students who have completed a financial
statement analysis course.
A future research idea stemming from this research is to determine empirically
through an archival study if these expenditures related to development costs do have
potential future value and should therefore be capitalized or if their benefits are exhausted
upon incurrence and should therefore be expensed. The results of our study indicate that
investors view these expenditures—material or immaterial and capitalized or expensed—
positively and anticipate future benefits to flow from them. However, the degree of
benefit differs as accounting method and size of the expenditure differ. Future archival
studies could investigate the actual market’s reaction to these expenditures as well as
attempt to capture if future benefits actually flow into subsequent periods as a result of
these expenditures.
Another future research idea is to test whether the deductibility for tax purposes
of expensed intangibles influences how companies account for their intangibles. The
primary motivator for railroads to begin accounting for deprecation expense was its
31
deductibility for tax purposes. In Japan, currently the majority of companies immediately
write off goodwill arising from consolidation against current earnings in order to get a
deduction for tax purposes. A tax effect may be influencing factor in how companies
account for intangibles. Given the option to do so and holding all other factors constant,
companies with high taxable income seem more prone to expense intangibles relative to
companies with little or no taxable income. However, a great disparity between financial
accounting and tax accounting exists. Therefore, merely because GAAP allowed the
capitalization of certain intangibles, the IRS would not automatically mandate similar
capitalization.
32
TABLE 1
Male
Female
Undergraduate
Master of Accountancy
Master of Taxation
Demographics of Subjects
Number
61
43
62
31
11
Percent
58.65
41.35
59.62
29.81
10.57
TABLE 2
Matrix of Results
This table represents subjects’ averaged responses to questions one, two, and the
combination of questions one and two found in the instrument. Accordingly, these scores
represent the best predicted values of the dependent variable calculated by the regression
equation. Scores range from one to ten, with one representing the most negative
perceptions about the intangible-related expenditure and ten representing the most
positive perceptions about the intangible-related expenditure.
Mean Scores for the Dependent Variables
Manipulation
Q1
Q2
7.714
7.000
Capitalize/Large
N=28
6.166
5.000
Capitalize/Small
N=24
7.333
6.167
Expense/Large
N=24
7.535
6.465
Expense/Small
N=28
Q1: The dependent variable is subjects’ responses to question one of the instrument,
which asks how beneficial the expenditure will be on future earnings.
Q2: The dependent variable is subjects’ responses to question two of the instrument,
which asks subjects how likely they would be to invest in the company described.
N: Number of subject who participated in this manipulation
33
TABLE 3
ANOVA
After reading about the research and development activities of an automobile
manufacturing company and analyzing its financial statements, subjects responded to two
questions regarding how beneficial the company’s intangible-related expenditures will be
on future earning. Univariate ANOVA is applied to the data collected in this experiment
to determine if the variance of method of accounting, size, and the interaction of these
two variables method of accounting and size accounts for the variance in investors’
perceptions of benefit of an intangible-related expenditure. Listed in this table are
ANOVA results when questions 1 and 2 are treated as the dependent variable. The sum
of squares and F-statistics of the overall ANOVA model, the independent variables, and
the interaction term comprise the table.
DV:Q1
Adj R2=0.131
DV:Q2
Adj R2=0.162
Sum of
F-stat
Sum of
Squares
Squares
36.568
6.177***
54.462
Model
6.309
3.197*
2.572
Method
11.693
5.925**
18.726
Size
10.027***
34.111
Interaction 19.788
***p-value<0.01; **p-value <0.05; *p-value <0.10
F-stat
7.618***
1.079
7.858***
14.314***
Q1: The dependent variable is subjects’ responses to question one of the instrument,
which asks how beneficial the expenditure will be on future earnings.
Q2: The dependent variable is subjects’ responses to question two of the instrument,
which asks subjects how likely they would be to invest in the company described.
34
TABLE 4
Pairwise Comparisons of Groups
This table explains the significant interaction term of the ANOVAs. The pairwise
comparisons show where differences among manipulated groups exist.
Group
1 vs. 4
1 vs. 3
1 vs. 2
4 vs. 3
4 vs. 2
3 vs. 2
*p-value<0.05
Group 1:
Group 2:
Group 3:
Group 4:
Difference; Q1=DV
0.1786
0.3810
1.5476*
0.2024
1.3690*
1.1667*
Difference; Q2=DV
0.5357
0.8333
2.0000*
0.2976
1.4643*
1.1667*
IFRS Treatment; Large Expenditure
IFRS Treatment; Small Expenditure
GAAP Treatment; Large Expenditure
GAAP Treatment; Small Expenditure
35
Appendix
Please read the information below and answer the questions that follow.
A major automobile manufacturing company located in the United Kingdom is heavily
engaging in research and development in order to make its automobiles more sustainable for
the future. With gasoline prices continuing to inflate, the company hopes to find alternative
methods of fuel which would also produce fewer harmful emissions into the environment. In
order to reduce CO2 emissions further and to create a supply of vehicles offering long-term
sustainability, the company is working to create lightweight components, alternative
propulsion systems such as hybrid cell and fuel cells, and electronic systems for improved
vehicle safety. The company promotes the improvement of fossil fuels and the development
and application of regenerative fuels. The research the company has conducted has led to the
company’s development of improved fuel-efficient vehicles which the company plans to
introduce into the market in the near future.
In accordance with International Financial Reporting Standards (IFRS), these development
costs were capitalized on the Balance Sheet as an Intangible Asset—Hybrid Development for
$5.3 Billion, which did not affect the company’s current year income. These capitalized
development costs will subsequently be amortized on a straight-line basis over the
expected useful lives of the products for which they were incurred.
The company
disclosed this asset on the face of the financial statements, specifically the balance sheet.
Based on your assessment of the partial financial statements which are illustrated below,
please respond to the questions that follow.
36
Statement of Income
(in millions of $)
Revenues
Cost of Goods Sold
Gross Profit
Selling, Administrative, and Other Expenses
Net Income
Balance Sheet
(in millions of $)
Assets:
Cash
Accounts Receivable
Inventory
Hybrid Development
Property, Plant, and Equipment
Goodwill
Total Assets
Liabilities:
Accounts Payable
Notes Payable
Other
Total Liabilities
Equity:
Common Stock
Add’l Paid-in Capital
Retained Earnings
Total Equity
Total Liabilities and Equity
151,000
126,000
25,000
18,500
6,500
7,100
60,000
17,700
5,300
70,900
1,700
162,700
13,700
91,200
7,800
112,700
2,700
8,600
38,700
50,000
162,700
37
Please read the information below and answer the questions that follow.
A major automobile manufacturing company located in the United Kingdom is heavily
engaging in research and development in order to make its automobiles more sustainable for
the future. With gasoline prices continuing to inflate, the company hopes to find alternative
methods of fuel which would also produce fewer harmful emissions into the environment. In
order to reduce CO2 emissions further and to create a supply of vehicles offering long-term
sustainability, the company is working to create lightweight components, alternative
propulsion systems such as hybrid cell and fuel cells, and electronic systems for improved
vehicle safety. The company promotes the improvement of fossil fuels and the development
and application of regenerative fuels. The research the company has conducted has led to the
company’s development of improved fuel-efficient vehicles which the company plans to
introduce into the market in the near future.
In accordance with International Financial Reporting Standards (IFRS), these development
costs were capitalized on the Balance Sheet as an Intangible Asset—Hybrid Development for
$300 Million, which did not affect the company’s current year income. These capitalized
development costs will subsequently be amortized on a straight-line basis over the
expected useful lives of the products for which they were incurred.
The company
disclosed this asset on the face of the financial statements, specifically the balance sheet.
Based on your assessment of the partial financial statements which are illustrated below,
please respond to the questions that follow.
38
Statement of Income
(in millions of $)
Revenues
Cost of Goods Sold
Gross Profit
Selling, Administrative, and Other Expenses
Net Income
Balance Sheet
(in millions of $)
Assets:
Cash
Accounts Receivable
Inventory
Hybrid Development
Property, Plant, and Equipment
Goodwill
Total Assets
Liabilities:
Accounts Payable
Notes Payable
Other
Total Liabilities
Equity:
Common Stock
Add’l Paid-in Capital
Retained Earnings
Total Equity
Total Liabilities and Equity
151,000
126,000
25,000
18,500
6,500
7,100
60,000
17,700
300
70,900
1,700
157,700
13,700
91,200
7,800
112,700
2,700
8,600
33,700
45,000
157,700
39
1. How beneficial will this intangible asset be to the company, in regard to
increasing future profits? (Will this asset help generate revenue and profits?)
Not
Beneficial
1
2
3
4
5
6
7
8
Very
Beneficial
9
10
8
Very
Likely
10
2. How likely would you be to invest in this company?
Not
Likely
1
2
3
4
3. What is your gender?
5
Male_____
4. What is your classification?
Undergraduate_____ MAccy_____
6
7
9
Female_____
MTax_____
MBA_____
Other______
Thank you for your participation!
40
Please read the information below and answer the questions that follow.
A major automobile manufacturing company located in the United States is heavily engaging
in research and development in order to make its automobiles more sustainable for the future.
With gasoline prices continuing to inflate, the company hopes to find alternative methods of
fuel which would also produce fewer harmful emissions into the environment. In order to
reduce CO2 emissions further and to create a supply of vehicles offering long-term
sustainability, the company is working to create lightweight components, alternative
propulsion systems such as hybrid cell and fuel cells, and electronic systems for improved
vehicle safety. The company promotes the improvement of fossil fuels and the development
and application of regenerative fuels. The research the company has conducted has led to the
company’s development of improved fuel-efficient vehicles which the company plans to
introduce into the market in the near future.
In accordance with US Generally Accepted Accounting Principles (GAAP), these
development costs were expensed on the Income Statement as R&D Expense, which reduced
the company’s current year income by $5.3 Billion. The company chose to disclose in the
notes of the financial statements that the expense was for development cost of improving
hybrid automobile production. Based on your assessment of the partial financial statements
which are illustrated below, please respond to the questions that follow.
41
Statement of Income
(in millions of $)
Revenues
Cost of Goods Sold
Gross Profit
Selling, Administrative, and Other Expenses
R&D Expense
151,000
126,000
25,000
18,500
5,300
23,800
Net Income
Balance Sheet
(in millions of $)
Assets:
Cash
Accounts Receivable
Inventory
Property, Plant, and Equipment
Goodwill
Total Assets
Liabilities:
Accounts Payable
Notes Payable
Other
Total Liabilities
Equity:
Common Stock
Add’l Paid-in Capital
Retained Earnings
Total Equity
Total Liabilities and Equity
1,200
7,100
60,000
17,700
70,900
1,700
157,400
13,700
91,200
7,800
112,700
2,700
8,600
33,400
44,700
157,400
42
Please read the information below and answer the questions that follow.
A major automobile manufacturing company located in the United States is heavily engaging
in research and development in order to make its automobiles more sustainable for the future.
With gasoline prices continuing to inflate, the company hopes to find alternative methods of
fuel which would also produce fewer harmful emissions into the environment. In order to
reduce CO2 emissions further and to create a supply of vehicles offering long-term
sustainability, the company is working to create lightweight components, alternative
propulsion systems such as hybrid cell and fuel cells, and electronic systems for improved
vehicle safety. The company promotes the improvement of fossil fuels and the development
and application of regenerative fuels. The research the company has conducted has led to the
company’s development of improved fuel-efficient vehicles which the company plans to
introduce into the market in the near future.
In accordance with US Generally Accepted Accounting Principles (GAAP), these
development costs were expensed on the Income Statement as R&D Expense, which reduced
the company’s current year income by $300 Million. The company chose to disclose in the
notes of the financial statements that the expense was for development cost of improving
hybrid automobile production. Based on your assessment of the partial financial statements
which are illustrated below, please respond to the questions that follow.
43
Statement of Income
(in millions of $)
Revenues
Cost of Goods Sold
Gross Profit
Selling, Administrative, and Other Expenses
R&D Expense
151,000
126,000
25,000
18,500
300
18,800
Net Income
Balance Sheet
(in millions of $)
Assets:
Cash
Accounts Receivable
Inventory
Property, Plant, and Equipment
Goodwill
Total Assets
Liabilities:
Accounts Payable
Notes Payable
Other
Total Liabilities
Equity:
Common Stock
Add’l Paid-in Capital
Retained Earnings
Total Equity
Total Liabilities and Equity
6,200
7,100
60,000
17,700
70,900
1,700
157,400
13,700
91,200
7,800
112,700
2,700
8,600
33,400
44,700
157,400
44
1.
How beneficial will this development expense be to the company, in regard to
increasing future profits? (Will this expense help generate revenue and profits?)
Not
Beneficial
1
2
3
4
5
6
7
8
Very
Beneficial
9
10
8
Very
Likely
10
2. How likely would you be to invest in this company?
Not
Likely
1
2
3
4
3. What is your gender?
5
Male_____
4. What is your classification?
Undergraduate_____ MAccy_____
6
7
9
Female_____
MTax_____
MBA_____
Other______
Thank you for your participation!
45
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